We have been waiting for a pull back for months now. The following factors make it look like that pull back may be here:
- Oil stocks have held stubbornly high due to the Iran controversy, while other forms of energy such as natural gas, coal, and solar have plummeted along with Basic Materials. I would expect oil stocks to retrace significantly in an overall US market pullback. Chevron (CVX) has been getting a large amount of negative press due to the Brazilian leak(s). Brazilians are even considering jailing some of its employees. This is negative both for the company and the industry. Transocean (RIG) is a part of this leak fiasco (after being part of the huge Macondo fiasco). As much as it has already been hurt, it is reasonable to expect it to fall significantly in a pull back. Many other companies such as EOG Resources (EOG), which has a lot of natural gas production, stand to fall hard if oil falls significantly. Total (TOT) is another stock that is suffering due to a leak/fire at a major development in the North Sea. It may well suffer more than others in an overall market pull back.
- With the hugely disappointing NonFarms Payrolls number of 120,000 versus an expectation of 200,000, the long awaited pull back is likely here.
- The fact that we have rallied into earnings season is a negative. In the recent past, when the market has done this, it has fallen during earnings season. In contrast when the market has sold off just prior to earnings season, it has rallied during earnings season.
David Zion of Credit Suisse, a top financial accountant, says that there will be huge pension funding shortfalls this year among S&P 500 companies. 114 companies will have to spend at least 10% of their average annual operating cash flow on pension liabilities. This will make it harder for them to beat the year ago earnings numbers.FY2011 earnings beat 2010 earnings handily, but 2010 earnings had still reflected many of the recession's problems. 2012 earnings come after a non-recession year (2011) of slow growth. They will have a harder time beating the previous year's earnings. Plus guidance is likely to be very conservative with an EU recession virtually a certainty in the near future.
Basic Materials stocks have had a very rough year so far. A lot of this has to do with China slowing. China recently lowered its GDP growth projection to 7.5% from 8.0% for FY2012. Plus the China CPI for March was 3.6%. This was more than the median estimate of 3.4%. Food-related costs gained 7.5%. This decreases the chance of China easing. It decreases the chance of a rally in Basic Materials. It means a lot of mining stocks will likely continue to do badly for some time. It means the large equipment suppliers for mining, construction, etc. will find a much softer market in China. Given that these industrials are already finding softer markets in the EU and to a lesser extent the US, industrial equipment is unlikely to do well. Rather these stocks are likely to fade.
The Nasdaq 100 ETF (QQQ) is up 21.3% this year alone. With the US economy growing at only 1%-2% this year (GS and MS) and the EU economy shrinking so far, this rise seems out of sync with reality. EU sales should suffer this year, especially with a rising USD almost assured. I note that the USD has already risen versus the Euro. This makes US goods more expensive. Many are expecting parity by the end of this year. If the US slows appreciably due to the EU recession, US sales should suffer too. I would expect Q1 earnings to at least hint at this weakness. I would expect the guidance issued by these companies to be much more conservative than many have been thinking. The Nasdaq stocks are ripe for a big pullback.
Some might think that precious metals are the place to be if one is expecting troubled times. However, a couple of items make me think otherwise. First gold (and other precious metals) historically perform poorly in a recession, and a major economic area, the EU, is having one. Typically people sell gold, etc. to raise money in recessions. A lot of people have to. Second India just raised its import tax on gold bars and coins to 4% from 2% (and the 2% tax had only been in effect since Jan. 2012). It also added a 1% excise tax on all jewelry. However, after a recent strike this last may be retracted eventually. We will likely see near term a bounce due to a government announcement that it would likely do this. However, the Indian government is still going to be trying to deter the importation of gold into India. India imported 930 tons last year, and gold is a big part of the Indian trade deficit. In effect the desire of Indians to protect themselves against inflation is resulting in more inflation (more devaluation of the Rupee). A Reuters survey of Indian jewelers, brokers, etc. estimated that the new taxes might cause a lessening of imports by 300 tons or more. With a retraction of the 1% excise tax likely, this estimate may be too high, but it will still not be far from reality.
The January 2012 US Trade Deficit was -$52.6B -- a big miss from the expected number. The February 2012 US Trade Deficit number is now expected to be -$52B. These numbers indicate that the US is buying fewer goods from US companies. By extension this means that US companies are selling less, and earnings will consequently be lighter than expected.
Goldman Sachs' Chief Forecaster, David Kostin, has recently revised his target for the next three months to 1275 for the S&P 500. His target for the next twelve months is 1250 for the S&P 500. These estimates are substantially below previous estimates, and they are substantially below may of the recent pumpers' numbers of 1400 or more for the S&P500 by the end of the year.
I am sure I have left out many more important factors. However, the bottom line is that the US stock market cannot reasonably expect to get a lot of help from Q1 2012 earnings. In fact earnings season is more likely to disappoint both in earnings and in guidance. People are looking for a pullback. The tea leaves say the are going to get one. You will likely be smart to play for this with some put options or some shorts. At the least, you should protect your portfolios against a substantial pull back.
These areas may get hit the hardest:
- Small cap stocks such as those in the Russell 3000 (IWV) or the Russell 2000 (IWM) usually get hit hard in such times. These are not bad indices to short (or buy puts on).
- The Nasdaq has likely risen farther and faster than is justified by the current economic situation -- 21.3% year to date. It is due for a pull back.
No one has all the answers. No one can give guarantees. However, I have presented a good case for a significant pull back. Traders/Investors should give the above presentation serious consideration.
Good Luck Trading.